A restatement related to 28 series of warrants for 13 quarters
Under tight deadline, the client needed to restate 13 quarters of warrant valuations
Project management, deadline-oriented restatement of warrant valuations
A publicly traded biotech company issued 14 separate series of warrants in conjunction with equity and debt financings over a five-year period. A key term in each warrant series was “down round protection,” which adjusts the exercise price and number of shares to be received upon exercise of the warrant should a subsequent financing take place at a lower implied equity value.
Warrants with down round protection are required to have their fair value estimates updated each quarter in accordance with ASC 815 — Derivatives and Hedging. Valuation specialists typically use sophisticated models to estimate the fair value of financial instruments with down round protection, because down round protection requires consideration of a large number of potential outcomes related to possible future financings.
After several quarters of updating warrant valuations, the company modified warrant terms in an effort to remove the conditions under which down round protection would be triggered. The company began using a simple Black-Scholes option valuation model to estimate the fair value of each series of warrants at each quarter.
With three weeks to go until the company was to file its 10Q, the company’s newly hired CFO realized that language in the modified warrant terms still provided down round protection and that several series had been omitted from valuation update analysis. The CFO decided to restate 13 quarters of warrant valuations for both the original and modified warrants. Because there was a transition period, and not all of the warrant holders accepted the modifications, there were a total of 28 series of warrants, with as many as 21 series outstanding at any given valuation date. The company engaged Grant Thornton LLP to lead the restatement efforts.
WHAT THE TEAM DID
Given the complex scope of the engagement, the timetable was very challenging. In addition to the challenge presented by the large number of valuation dates and variety of warrant contractual terms, exercise prices and underlying share counts of warrants had changed as subsequent financings over previous years had triggered down round protection terms in outstanding warrants. Most warrants also included a separate term that gave put rights to warrant holders in the case of a specific type of financing allowing sale of the warrant back to the company at the value of the warrant at the time of the triggering financing. Grant Thornton’s complex financial instruments professionals had to consider an extensive range of potential financing scenarios.
Grant Thornton worked closely with the company to develop a project management process that captured all significant details at each valuation date accurately, and correctly assigned the assumptions about future financings. Working around the clock, Grant Thornton provided a complete set of detailed schedules and accompanying narrative reports enabling careful company review of contractual, market and scenario assumptions within three weeks of beginning the engagement.
The company implemented a reliable process that addressed a complex collection of financial instruments over a multiyear timetable. Efficient communication between Grant Thornton and the company minimized the effort required by the company to update financial statements across many dates. Grant Thornton’s rapid response enabled the company to understand the impact of updated warrant values across the dates and consider how best to communicate with the market. Ultimately, the company was able to make a timely statement to the market about the impact of warrant fair value restatement and to complete its 10Q filing in a timely manner, minimizing potential negative stock price impact from delay.